Focus Article: Quality Systems Inc. (QSII)

Quality Systems Inc. (QSII) $17.06

The Company:

Quality Systems is an enterprise software company that provides healthcare information services for medical and dental group practices and hospitals throughout the United States. The company was formed in 1973 in Irvine, California as a dental software company. QSI purchased Clinitec in 1996 and Micromed in 1997 and combined the two to create NextGen Healthcare Information Systems. NextGen Healthcare Information Systems develops and sells electronic health records (EHR) solutions, revenue cycle management applications and connectivity services to the healthcare industry. The dental software segment of the company accounted only for 5% of overall revenue of $417.9 million in fiscal 2012 ended March 2012.

The primary thesis for investing in Quality Systems is that the American Recovery and Re-investment Act (ARRA)  provides over $60 billion in incentive and grant money to stimulate electronic health record (EHR) adoption. Quality Systems is pure play company that provides EHR software and services. According to estimates provided by the company, EHR adoption is only 40 to 50% today and more than half the market is yet to convert to electronic health records.

The company has generated double digit top line and bottom line growth over the last five years without taking on any debt and actually sports a very strong balance sheet (total assets are three times total liabilities).

Quality Systems Revenue Growth

Quality Systems Revenue Growth

Quality Systems Operating Income

Quality Systems Operating Income

QSI saw two large insider purchases reported on July 31. George Bristol, a member of the Board of Directors, bought 10,000 shares at an average price of $16.02 and fellow Board member Russell Pflueger also bought 10,000 shares at an average price of $16.06. On the other hand, Ahmed Hussein, a dissident board member at QSI sold more than 3.5 million shares over the past week. Mr. Hussein’s sales were related to margin calls. Mr. Hussein has launched a proxy battle against the company by urging shareholders to vote for his slate of seven board nominees at the company’s annual meeting in August. On July 31, Quality Systems Board issued a special bulletin to its shareholders announcing that trading by Ahmed Hussein violated the company’s internal trading policy and that it had contributed to QSI’s share price decline. According to the last SEC filing by Mr. Hussein, he still owns 5.825 million shares representing 9.8% of the company’s outstanding shares. The large proxy firm Institutional Shareholder Services (ISS) has recommended that shareholders vote in favor of Quality Systems’ nominees for the board.

While the stock is off significantly, dropping from a high of over $50 last September, there is a chance it may see additional dips if Mr. Hussein continues to see margin calls. However the drop in the stock price before the recent dip was driven by an 18.4% decline in fiscal Q1 earnings and a sharp drop in operating margins from 28.7% last year to 19.9% this year despite double digit revenue growth. Increased R&D and SG&A costs along with a delay in signing a few large contracts were partially responsible for the earnings miss and drop in margins.

Business Statistics & Financials:

The company reported fiscal Q1 2013 revenue of $118.3 million, up 18% year-over-year from $100.4 million in Q1 2012. As mentioned above, earnings declined 18.4% to $15.5 million from $19 million last year. More than a two-thirds of their revenue was derived from maintenance and software services when compared to higher margin software sales.

The company has $135 million in net cash and investments on its balance sheet or $2.27/share. Quality Systems trades for a little over 7 times EBITDA and 3.3 times book value. The company sports a dividend yield of 4.1% with a payout ratio of 57%. Even if earnings for the rest of the year remain at the same level as they were in Q1, the payout ratio would be around 70%, making a dividend cut unlikely.

Competitors:

Stock Symbol Mkt Cap EV/EBIDTA P/B Operating Margin
McKesson Corporation MCK 20.63B 7.61 2.87 1.91%
Cerner Corporation CERN 12.61B 17.94 4.83 21.59%
athenahealth, Inc. ATHN 3.42B 64.85 12.31 8.21%
Allscripts Healthcare Solutions, Inc. MDRX 1.75B 7.79 1.16 10.93%
Quality Systems Inc. QSII 1.01B 7.26 3.18 24.77%
Medidata Solutions, Inc. MDSO 864.00M 21.72 7.29 13.92%
MModal Inc. MODL 776.97M 9.06 6.19 16.15%
WebMD Health Corp. WBMD 758.12M 9.1 1.43 9.78%
Computer Programs & Systems Inc. CPSI 544.02M 12.41 8.78 22.40%

Insider Buying:

Three insiders purchased stock on the open market over the last six months as listed below. You can view a list of all insider transactions for Quality Systems Inc. here.

Owner Relationship Date Cost # Shares Value($) Total Shares
George H Bristol Director 31-Jul $16.02 10,000 160,200 17,000
Russell Pflueger Director 31-Jul $16.06 10,000 160,600 19,000
Steve Puckett EVP Hospital Solutions 13-Jun $27.59 1,250 34,488 1,250

Conclusion:

For a company with operating margins of nearly 20% and double digit revenue growth, the stock is undeniably cheap. The company also pays out a 4.1% dividend while you wait for capital appreciation. However the company did not reaffirm fiscal 2013 guidance and has currently suspended providing forward guidance on account of challenging market conditions. In light of these developments, the stock is probably going to be dead money for a while. The wild card here is the potential of an acquisition bid from one of its partners like Dell or a larger competitor like McKesson.

 

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